For any investment to be beneficial it must ensure cash flows to back interest costs and principal. On top of that, investors will look for a return on invested capital. From a macroeconomic perspective, when these conditions are not met, then those investments subtract from GDP growth.
The recent 16+1 meeting between 16 Eastern European countries and China in Dubrovnik gained additional coverage because Italy has signed up for Chinese investments and Greece is hoping to make the club 17+1 soon.
Local press has been full of investment initiatives which could be realised through the Belt and Road Initiative (BRI), many of them wishes, from high-speed rail links to stadia. Respected commentators have claimed the EU doesn’t have the funds at their disposal while China is flush with cash, so it makes sense to bat eyelids at them in the expectation of realising investments.
There is nothing wrong per se with Chinese investment in my opinion. What small EU member states need to ensure is that their decision-making processes factor in all the costs and benefits, risks and opportunities.
The politics of investment decisions are also important
The first thing to note is that most of the 16 Eastern European countries of which 11 are EU members states have joined the EU, some of them not that long ago. They need to prove their worth and credibility to that club so should openly consider how and whether Chinese investment might adversely affect their relationships with Brussels, large EU member states and the US. There will always be a point in the future where each of these nations will need the support of the US and large EU member states for something important – understanding this, and making sure you build up credits so that you can cash them in when most needed, is the essence behind the choice of joining the Euro-Atlantic Club of EU and Nato.
Charges of hypocrisy, along the lines of all the large EU member states and the US trade with China so why can’t we source investments from them, ring hollow. No one, for example, criticises Germany for selling as many goods as it can to China. Notice though, when Germany supports the Nordstream II pipeline, which bypasses Ukraine, condemnation follows from both Eastern and Western European member states and the US.
While large, influential EU member states such as Germany may well conclude they can deal with the criticism, smaller, less influential EU member states would be wise to consider burnishing their EU solidarity credentials by forgoing even potentially more profitable investment opportunities and strategic investments in the interests of maintaining a common EU stance on relations with third states, especially where those states are potentially hostile, non-democratic and/or do not conform to EU values.
Not every investment initiative is beneficial
The siren song of simplicity, which is attached to Chinese investment, in the sense that cost-benefit analyses and similar niceties are less rigorous compared to EU rules, is another issue. If cost-benefit analyses show a project generates net costs, then the often-unpalatable truth is that you do not need that investment. There is an implicit assumption in much press in South East Europe that every investment is beneficial. If only.
Currently, China and its investments are flavour of the month. Growing up in Australia in the 1980s Japan could do no wrong and serious people were concerned Japanese investment would buy up everything of worth in Australia. Similar concerns were voiced elsewhere too. We all know how economic growth in Japan has fared since 1989. A generation earlier, the Soviet Union was also growing strongly and flexing its muscles, until it could no longer do so with entropy setting in in the 1970s – we also know how that ended.
China may well be different, but the point is that for any investment to be beneficial it must ensure cash flows to back interest costs and principal. On top of that, investors will look for a return on invested capital. These are very high bars to meet. From a macroeconomic perspective, when these conditions are not met, then those investments subtract from GDP growth.
Look no further than Montenegro to see how this manifests itself. There a motorway to Serbia, which may have made more sense while the country was part of Serbia and Montenegro, the first section of which is largely financed by China, is not going to plan – the country’s borrowing capacity to finance the rest of the construction is questionable. The IMF estimates that this year Montenegro’s public debt would have been 59% of GDP instead of 78% without the project and that an austerity program commenced in 2017 would not have been necessary has the project not gone ahead. Years of discipline by successive Montenegrin governments will be necessary to ensure a lower public debt trajectory in order to maintain access to international financial markets. The loss of policy space is a high price to pay for an infrastructure investment.
There are numerous examples of Chinese funded investments turning out less viable or riskier than expected. The most evident example is in Sri Lanka where the port of Hambantota has been transferred to China for 99 years. This swap enables Sri Lanka to service remaining external debt, for now. Meanwhile, earlier this year, the Kenyan press leaked details of the contract for the Mombasa Nairobi railway which suggests the country is exposed to the same risk of asset transfers as Sri Lanka.
The benefits of the EU’s approach to investment for EU member states
The example of the Pelješac bridge in Croatia shows competing interests can be squared. Still, it remains uncertain how many more infrastructure projects the EU is willing to finance which Chinese companies construct. Unlike China, which offers financing and insists on its labour being engaged, the EU provides grants to projects which meet its stringent criteria, including environmental protection and the contribution to the regional economy while aligning to the EU policy of smart, sustainable and inclusive growth. This ensures greater transparency, necessarily means a potential investment will be put through a rigorous cost-benefit analysis and does not expose national budgets to undue risk. Admittedly, an investment financed by a loan from China will probably be realised more quickly, but as the examples of Sri Lanka, Kenya and Montenegro show, the costs can be great. Speed kills, not just on roads.
Despite claims to the contrary, the EU has ample resources to finance infrastructure and other initiatives, especially in small members states whose economies have not yet converged to EU standards of living. Organising a tender process to EU standard demonstrates commitment to EU rules, reduces risk to public finances and, just as importantly, increases the likelihood that those investments genuinely make economic sense. Ultimately, such an approach to investment assessment is more beneficial to those states in ensuring that important infrastructure projects and public spending are subject to greater democratic scrutiny and accountability.